The Strategic Importance of the Global Oil Market

This Letort Paper will explain why the confluence of four major factors: 1) rising oil supplies, 2) weak oil demand, 3) financial shifts on Wall Street, and 4) a strong U.S. dollar far outweigh the geopolitical risks in the Mideast and put downward pressure on oil prices. This Paper analyzes the concomitant factors that are now putting upward pressure on oil prices, as well as those that continue to keep oil prices relatively low. 

On the supply side, lower oil prices in part reflect booming U.S. oil production. The real “game changer” is the recent discovery of 30 more years of unconventional oil. The global oil market is now “swimming” in one trillion more barrels of oil that was not included in the world oil supply a few years ago. This new oil supply mostly breaks down into three types of unconventional extraction of oil: Brazil’s deep water oil, U.S. shale oil, and Canada’s oil sands. 

On the demand side, there continues to be a sluggish global economy. For instance, Japan, Germany, and Italy are all suffering from near economic contraction. China’s growth is rapidly slowing down and is a far cry from its double digit growth in the past. Meanwhile, the U.S. economy was also weak after the global financial crisis. In an effort to boost gross domestic product growth, the federal government (Fed) under Ben Bernanke loosened the monetary policy (increased the growth of the money supply), which in turn caused oil prices to rise as a hedge against expected inflation and a weak dollar, but runaway high inflation never happened. So now the Fed (under Janet Yellen) is planning to tighten monetary policy by reducing (or tapering) the pace of growth of quantitative easing, which, in turn, will strengthen the U.S. dollar. A stronger U.S. dollar buys more oil and therefore lowers crude oil prices. 

In sum, the major factors that determine average oil prices have all been pointing in a downward direction. In fact, in 2015, there is likely to be a growing surplus of oil on world markets created by rising oil production in the United States, Canada, and a few other countries. The result has been falling oil prices. Low oil prices have created winners and losers. Winners include the global economy as a whole, and consumers, especially U.S. consumers, and net oil importing countries. Losers include oil investors, net oil exporting countries, oil producing companies, and the workers that have been laid off by these oil exporting companies and countries. This Paper discusses why the winners are benefitting, why the losers are suffering, how the winners and losers are responding, and how their responses will affect oil prices down the road.